The SDS Requirement That Catches Most Agencies Out

If your agency engages contractors through a limited company, you have a legal obligation to issue a Status Determination Statement (SDS) before that contractor does any work. This is not optional. It has been mandatory for medium and large agencies since April 2021, and HMRC is now actively checking compliance.

The SDS is the document that sets out whether the contractor falls inside or outside IR35. If you get it wrong, or if you do not issue one at all, the liability for unpaid tax and National Insurance falls on your agency. Not the contractor. Not the end client. You.

We have seen agencies hit with six-figure bills because they assumed the end client would handle the determination, or because they used HMRC's CEST tool without understanding its limits. As ICAEW qualified accountants who work exclusively with agency founders, we want to make sure you have the practical detail you need.

This article covers the legal requirements for an SDS IR35 agency document, the four key employment tests you must apply, and a template you can adapt for your own engagements.

What the Law Says About an SDS

The off-payroll working rules (Chapter 10 of Part 2 of ITEPA 2003) require three things from the agency that is the fee-payer:

  • You must make a determination of the contractor's employment status for each engagement.
  • You must give the contractor an SDS setting out that determination and the reasons for it.
  • You must do this before the contractor starts work.

If the contractor is inside IR35, you must also deduct PAYE and National Insurance from their payments and pay employer NI at 13.8%. If the contractor is outside IR35, you pay them gross through their limited company, but you must still have a valid SDS on file.

The SDS must be issued for each separate engagement. A single contractor working on three different projects for three different end clients needs three separate SDS documents. A contractor working on a rolling monthly retainer for the same end client can have one SDS that covers the whole engagement, provided the working practices do not change.

The Four Tests That Determine IR35 Status

HMRC does not give you a checklist to tick. The SDS must show you have considered the specific facts of the engagement. In practice, the determination comes down to four key tests that the courts have developed over decades of case law.

1. Substitution and Personal Service

Can the contractor send someone else to do the work? If the contract says the work must be done by a named individual, and the end client would reject a substitute, that points towards inside IR35. If the contractor can send a competent replacement without the end client's approval, that points towards outside IR35.

The key is whether the right of substitution is genuine and unfettered. A clause that says "the contractor may send a substitute subject to the client's reasonable approval" is generally acceptable. A clause that says "the contractor may send a substitute only if the client agrees" is weaker, because the client can simply refuse.

2. Control

Who decides what work is done, when it is done, and how it is done? If the end client tells the contractor which tasks to complete, in what order, and by what method, that is control. If the contractor decides their own working hours, their own approach, and their own priorities within a project brief, that is less control.

Control is the most important factor in most IR35 cases. HMRC and the tribunals consistently give it the most weight. A contractor who has genuine control over their working day and methods is far more likely to be outside IR35.

3. Financial Risk

Does the contractor bear any financial risk? A contractor who is paid by the hour or day with no risk of loss if the project goes wrong is more likely to be an employee. A contractor who quotes a fixed price, covers their own costs, and takes the risk of a loss if they underquote is more likely to be genuinely self-employed.

Financial risk can include having to correct mistakes at their own cost, paying for their own equipment and software, and having no entitlement to holiday pay or sick pay.

4. Mutuality of Obligation (MOO)

Is the end client obliged to offer work, and is the contractor obliged to accept it? If the answer to both is yes, that is MOO, and it points towards employment. If the engagement is project-based with no ongoing obligation on either side, that points towards self-employment.

MOO is often present to some degree in any commercial relationship. The question is whether it goes beyond the specific engagement. A retainer agreement with a notice period creates more MOO than a one-off project with no expectation of further work.

What Your SDS Must Include

There is no prescribed HMRC form for an SDS. The legislation says it must set out the conclusion and the reasons for it. In practice, a strong SDS should contain the following:

  • The name and address of the contractor's intermediary (usually their limited company).
  • The name and address of the end client.
  • The start date and expected duration of the engagement.
  • A clear statement of the determination: inside IR35 or outside IR35.
  • The reasons for the determination, referencing the specific facts of the engagement and how they apply to the four tests above.
  • The date the SDS was issued.
  • The name and role of the person making the determination.

You must also inform the end client of your determination if you are the fee-payer. In most agency engagements, the agency is the fee-payer, so you must give the SDS to the contractor and tell the end client what you have decided.

A Practical SDS Template for Agencies

Here is a template you can adapt. This is not legal advice, but it covers the key elements that HMRC and the tribunals look for.

STATUS DETERMINATION STATEMENT

Engagement Reference: [Agency ref number]
Date of SDS: [Date]
Contractor Intermediary: [Limited company name and registered address]
End Client: [Client name and address]
Engagement: [Brief description of the work, e.g. "Senior PPC Manager for Google Ads retainer, 3 days per week, 6-month initial term"]

Determination: This engagement is determined to be OUTSIDE the off-payroll working rules (IR35).

Reasons for Determination:

Substitution: The contract includes an unfettered right of substitution. The contractor may send a suitably qualified replacement without the end client's approval. The contractor has provided evidence of a substitute who is available to step in if needed.

Control: The contractor sets their own working hours and determines the methods used to achieve the agreed project milestones. The end client provides a brief and approves deliverables, but does not direct how the work is done day-to-day.

Financial Risk: The contractor bears financial risk. They are paid a fixed monthly retainer and must cover any additional costs if the project scope expands. They provide their own laptop, software licences, and professional indemnity insurance.

Mutuality of Obligation: There is no ongoing obligation beyond the 6-month term. Neither party is obliged to offer or accept further work after the engagement ends. The contractor has no entitlement to holiday pay, sick pay, or other employment benefits.

Person making the determination: [Name], [Role], [Agency name]
Date: [Date]

If your contractor mix has changed in the last 12 months, ask your accountant before year-end whether your SDS documents are compliant. A template is a starting point, not a substitute for proper legal and tax advice on each specific engagement.

Common Mistakes Agencies Make with SDS Documents

We see the same errors repeatedly when we review SDS documents for agency clients. Here are the most common ones.

Using a blanket determination. You cannot decide that all contractors at your agency are outside IR35. Each engagement must be assessed on its own facts. A blanket approach is a red flag to HMRC.

Relying solely on the CEST tool. HMRC's Check Employment Status for Tax tool gives directional guidance, but it is notoriously unreliable for complex arrangements. It does not handle substitution well, and it often produces a result that contradicts tribunal decisions on similar facts. Use CEST as a starting point, not as your only evidence.

Not updating the SDS when circumstances change. If a contractor starts taking more direction from the end client, or if their working pattern shifts, the original SDS may no longer be valid. You should review SDS documents periodically, especially for long-term engagements.

Issuing the SDS after the contractor starts work. This is the most common compliance failure. The SDS must be issued before the contractor performs any work. If you are already paying a contractor and you have not issued an SDS, you are carrying the risk.

Not keeping a record. HMRC can ask to see SDS documents for up to six years. You need a system for storing them, ideally with the contract and any supporting evidence like emails or timesheets.

What Happens If You Get It Wrong

The consequences of getting an SDS wrong are significant. If HMRC determines that a contractor should have been inside IR35 but you classified them as outside, your agency is liable for:

  • The unpaid income tax and employee NI that should have been deducted from payments.
  • The employer NI at 13.8% that should have been paid.
  • Interest on the late payments.
  • Potential penalties, which can be up to 30% of the tax due for careless errors or 100% for deliberate ones.

These liabilities can run into hundreds of thousands of pounds for a mid-sized agency with several contractors. We have seen one agency face a £140,000 bill because they classified three senior contractors as outside IR35 without proper evidence, and HMRC disagreed.

The liability sits with the fee-payer, which in most agency engagements is the agency itself. Even if the end client made the determination, if the agency is the fee-payer and does not have a valid SDS, the agency carries the risk.

When to Get Professional Advice

If you have one or two contractors on standard project terms, you can probably handle the SDS yourself using the template above and the CEST tool as a cross-check. But if any of the following apply, you should get professional advice before issuing the SDS:

  • The contractor works full-time hours for a single end client.
  • The contractor uses the end client's equipment and systems.
  • The contractor is managed directly by the end client's staff.
  • The engagement has lasted more than 12 months.
  • The contractor previously worked as an employee for the same end client.

In these scenarios, the risk of HMRC challenging the determination is higher, and the cost of getting it wrong is greater. A proper review by a qualified accountant or employment tax specialist is money well spent.

At Agency Founder Finance, we help agency founders get their IR35 compliance right. If you want us to review your existing SDS documents or help you set up a process for new engagements, get in touch.